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SSB Warns of National Power Problems

The future is bright for investors in the power market, but
rather dim for the nation's power users, Salomon Smith Barney (SSB)
warned in a new report titled "The U.S. Electric Shock."

SSB said the power crisis won't be confined to California and
the West for very long. Power shortages are going to spread to
eastern states over the next few years not only because of delays
in power plant construction but also because of delays in gas
supply development and constraints on the gas pipeline grid.

"In our opinion, the investment community's media driven focus
on California's electric power problems has led many to miss the
bigger picture," the report stated. "The current U.S. economic
weakness is masking electricity needs near term."

Current poor economic conditions mean power consumption from
industrial customers, who account for 32% of the country's electric
power usage, is below the trendline, according to SSB. As a result,
reserve margins "look a bit healthier than they will once economic
recovery ensues. Hence, we are likely to hear about more brownouts
and rolling blackouts around the nation and not just Stage Three
alerts in California. The warning signs are there but are being
overlooked, in our view."

SSB said disparate state-by-state deregulation and the
uncertainties surrounding timing and cost of fuel sources, have
hindered generation construction. "[S]everal policies may be needed
to encourage [generation construction], including allowing prices
to spike short term as market forces act freely, creating
incentives to speed new investment. In addition, environmental
objections may need to be balanced against siting needs for new
power plants. Some have even argued that pollution constraints may
need to be relaxed near term so that coal-fired power can be used
until the new gas-fired plants get completed."

Another thing to bear in mind is that forecasts have erred on
the side of slower demand growth, SSB said. A key problem in the
California crisis was that electricity demand had been forecast to
grow only 1.8%/year by the North American Electric Reliability
Council (NERC) in 1990. Annual economic growth in the state
averaged 2%-3% while Californian power needs actually grew 4%-6%.

Reserve margins are plummeting nationwide. In the early 1980s,
reserve margins nationwide got up to 30% but now have dropped to
about 15%. New England, New York, New Mexico, Arizona, and southern
Nevada in particular are areas of concern. "These areas are regions
where generation reserve margins are not sufficient enough during
peak load conditions usually associated with extended heat waves,
but this does not fully build in the potential for industrial
recovery, in our opinion. States in the Southeast, the Midwest, the
West, and the Pacific Northwest could be affected by electricity
shortages."

Recovery of the chemical industry also could trigger power
shortages. Chemical processing alone accounts for nearly 10% of the
nation's electricity use. States such as Texas, Oklahoma,
Louisiana, and New Jersey would be most affected by a recovery in
the chemicals sector, which is down 20% year over year currently.

"The Southeast could also be hit if the paper industry
recovers," SSB said. "Moreover, should smelters be put back into
production, we think that the Pacific Northwest and Arizona could
experience additional power pressures. Plus, if manufacturing
rebounds, the Midwestern U.S. could face challenges."

Another major hurdle will be continuing the transition to an
electricity superhighway through formation of regional transmission
organizations. Currently, 33% of electricity users are being served
by an RTO with another 22% waiting for approval, according to the
SSB report. By the end of the 2001, it is likely that as much as
80% of U.S. customers will be served by RTOs. The existing system,
however, wasn't built to be a superhighway. It was meant to deliver
supply from a generating facility to a set of customers, i.e.,
point to multi-point, not multi-point to multi-point. "In 1995,"
SSB said, "25,000 inter-regional transactions took place and that
number hit two million in 1999; thus, many transmission lines are
basically 'maxed out!' Thus, access to power becomes questionable."

One other factor is that FERC cannot use federal eminent domain
powers to push through construction of power transmission in the
same way it pushed through gas pipeline construction. State and
local regulators have considerable control over the power
transmission system. As a result energy policy changes are needed
in this area on a broad scale.

NERC estimates that more than 10,000 MW of generating capacity
will have to be added nationally every year through 2008 just to
keep up with the 1.8% annual growth forecasts, "which could easily
be too low," according to SSB. New gas wells, pipelines and power
transmission lines must be built to keep up with the growth, and
generators will need open access to the grid. A lot of work clearly
needs to be done in a short period of time.

For information on the report, contact Salomon Smith Barney at
(212) 428-5200.

Rocco Canonica

&COPY;Copyright 2001 Intelligence Press, Inc. All rights
reserved. The preceding news report may not be republished or
redistributed in whole or in part without prior written consent of
Intelligence Press, Inc.

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